The Last Bastion

Computers began automating processes in the 1950s. Early computing was primitive by current standards, but computers could perform tasks in a fraction of the time that humans could. Since that point in time, everything from accounts payable to sophisticated investment pricing models has been automated. However, there has been at least one holdout in the rush to computerization. Over its 211 years of existence, the New York Stock Exchange (NYSE) has repeatedly refused automated execution of trades in favor of the tried-and-true auction market. To the NYSE, people -- not machines -- provide the ideal method of determining optimal stock prices.

That model may be on the verge of change. John Thain, who became leader of the NYSE in recent months, advocates increased technology in the trading of stocks. Indeed, the NYSE faces significant competition among its electronic rivals, notably the NASDAQ and Archipelago.

The NASDAQ stock market debuted as the first electronic stock exchange in 1971. It claims to routinely handle more than 15,000 transactions per second, processing 441.7 billion shares in 2002. The objective of NASDAQ is to provide a more fair, more level playing field for all market participants. NASDAQ broadcasts bid and ask quotations for each security over the network, providing transparency into the marketplace. All market participants, not just professional traders, see the same information at the same time.

Why is the NYSE model considered unfair? Companies pay fees to license seats on the stock exchange; the ones that have seats get more trade volume/business than those that don't. Professional traders occupy the seats on the exchange and rely on shouting to broadcast bid and ask prices. It's been a network of physically bringing together buyers and sellers, but it has been criticized for being cumbersome and subject to human error. Granted, the NYSE has the capability for electronic trades, but it has had restraints that have limited such trades and, thus, the credibility of the network itself.

Enter Archipelago, an electronic communications network (ECN) created in response to SEC order-handling rules implemented in 1997. Archipelago was approved by the SEC to provide electronic trading capabilities, and has effectively created a national limit order book for NASDAQ stocks. Archipelago is the first totally open electronic exchange, trading all NASDAQ, NYSE, AMEX, PCX (Pacific Exchange) and OTC (over the counter) securities. It is totally electronic and prides itself on providing equal information to all investors, being more fair in its execution of trades than a people-based model.

The NYSE has a storied 211-year history; however, the incredible technological advances of the last 50+ years have obviated the need for a people-based system of shouting across a floor crowded with stock traders. The NYSE needs to move into the future of stock trading and give up (albeit reluctantly) the antiquated method of verbally creating a market. It is so much easier and more fair to create a market electronically, where information is available to all participants instantaneously.

The NYSE is facing increasing competition in terms of listings as well as trades. Several NYSE-listed companies recently have requested dual listings on both the NASDAQ and the NYSE to increase trading capabilities. The NYSE is also facing electronic competition from both the NASDAQ and Archipelago, as well as other ECNs. The NYSE is the last bastion of public outcry market models. The market is simply being replaced by more efficient and effective electronic models. Most of us have gotten over the initial "indignant" response to being replaced by a machine for routine tasks, but the NYSE stock exchange model reminds us of days long past and fondly remembered. Perhaps that is why adoption of new methods is particularly difficult for the exchange. The last bastion of electronic outcry models is running up against the new world order of fair, best-price electronic trade execution.

Time will tell whether or not the NYSE can compete with other electronic exchanges. However, it really must succeed with this goal -- or face failure as an overall trading mechanism. The market will find its most natural process for performing trades. That's just the way it works. It just seems as though electronic trades will ultimately provide the process by which information is exchanged at a speed commensurate with the need to understand. NASDAQ and Archipelago provide increased capabilities for understanding; NYSE would be wise to follow suit.